CMS Expert Guide to cash pooling in Czech Republic

a) Intro 

Cash pooling is not directly regulated under the laws of the Czech Republic as a specific type of financial arrangement. Nevertheless, the generally accepted position is that cash pooling is an intra-group arrangement for the provision of financial accommodation and, as such, is directly and indirectly regulated by corporate, banking, insolvency, tax and other local regulations. 

b) Social interest and due diligence

Generally, when entering into a cashpooling structure, the executive directors of a Czech company are subject to duties arising from Czech law, in particular from the Act on Business Corporations. These duties require that executive directors should always act with due care and in the interests of the company. In the event of a breach of these duties, they can be held liable. The directors must notify the respective corporate bodies of any potential conflict of interest, which may arise between the director’s interests and the interests of the company during the exercise of the director’s office.

c) Shareholder’s loan provisions

There are no specific regulatory restrictions concerning the provision of intragroup loans under Czech law and no licenses or registrations are required from a Czech law perspective for a Czech company to participate in the cashpooling. Unlike other jurisdictions, there is no automatic subordination of shareholder’s loan in case of the insolvency of its Czech subsidiary.

d) Liquidity protection

There are not specific Czech regulatory requirements requiring for the directors to observe any specific liquidity protection regulations, however ensuring sufficient liquidity for the company is one of the elements of due care of directors. Therefore, if the payments to the poll caused the company to become insolvent or are made while the company is already insolvent or overindebted, the directors may be personally liable. In light of this, it is recommended that the Czech company sets up a suitable monitoring programme in order to check on an ongoing basis (i) the state of indebtedness of the Czech company; and (ii) whether the master account has adequate liquidity to provide all cashpooling participants with the required liquidity.

e) Hidden distribution of profits

Profits must only be distributed to shareholders subject to a formal shareholder resolution and in compliance with statutory provisions. Hidden distribution of profits is not allowed under corporate law and may also have adverse tax consequences. Hidden distribution of profits is deemed to exist whenever the company makes payments to the shareholders or their close persons in the absence of an equivalent consideration.

For cash pooling scenarios this indicates interest at usual market rates. An upstream loan may not be granted without interest being paid at usual market rates and, conversely, downstream loans may not be granted at excessively high rates of interest which are inconsistent with normal market rates.

f) Insolvency proceedings – contestation of transactions

Insolvent companies or companies in threatening insolvency should be generally excluded from cash pooling, as it involves various risks for all participants to the cash pooling.

One risk is the prohibition of repayment of the loan or similar performance while the company is in insolvency irrespective of whether the insolvency has been formally declared. Such repayment will be at risk in the insolvency proceedings, when the insolvency administrator can challenge transactions of an insolvent company, such as payments granted to other group companies, for statutory reasons (in particular as a preferential transaction). The recipients must then reimburse the respective amount into the insolvency estate.

The general period for the insolvency administrator to challenge the transactions occurring as long as one year before the start of insolvency, extended to three years if the transaction was made between close persons or group companies.

a) Intro

Acting with due care and in the interest of the company is the primary legal duty of each director of a Czech company and every other person that is in similar position as the director, such as proxy or a shadow director. Breach of the duty may lead to personal liability of the directors and in extreme cases also to criminal liability. Liability of shareholders for the business results of the company is rather limited, however cannot be fully excluded. The risk of liability becomes particularly significant if one of the participating companies becomes insolvent, or is sold, since it is at this point that an insolvency administrator or the incoming directors of the sold company may pursue such claims.

b) Liability of directors

There are a number of situations, when a breach of the due diligence of directors may lead to serious liabilities. For example, if a director contributed to the insolvency of the company by breaching the duty of due care, the insolvency court may require that such director returns any benefit received by such director from the company in the last two years and/or that such director must repay to the creditors debts that cannot be satisfied in insolvency from the assets of the company. In addition, a court may disqualify a director from the right to be a director in any company for as long as three years. Therefore it is recommended that the cashpooling structure enables the directors of Czech companies to retain control over affairs of the company and be fully informed about the financial performance of other participants that could have impact on its liquidity or solvency. 

c) Liability of shareholders

In the case of affiliated parties, a special category of liability exists for an influential entity (typically a shareholder or another controlling entity), which requires that entity to compensate damage caused by arrangements that are harmful to an influenced entity, such as its subsidiary. 

The liability can be avoided if the influential entity proves that it was acting in good faith and it can be reasonably assumed to have been acting:

1. on an informed basis; and
2. in a justifiable interest of the influenced entity.

In the relationship between a parent company and a Czech subsidiary, the parent company could be considered as the influential entity, and a dominant entity, in which  case, the parent would be liable for damage caused to the Czech subsidiary by exercising its influence over the Czech subsidiary. Such damage would need to be settled with an adequate consideration or other demonstrable benefit to the Czech subsidiary, arising from its membership in the relevant group.

In order to reduce the above risks in case of the participation of the Czech subsidiary in the group cashpooling structure, the parent should be acting on an informed basis and in a justifiable interest of the Czech subsidiary.

a) Intro

It is recommended that the relevant risk reducing legal structure is established upon the review of the required cashpooling structure on case by case basis. Since there are no specific cashpooling regulations in the Czech Republic, it is necessary to apply general legal principles and protective measures on the basis of the major risks arising from the relevant cashpooling structure. In any case, cashpooling transaction is from the liability risk perspective similar to other intra-group relationship and loan arrangements and the company should be able to mitigate these risks by diligent preparations and review of the relevant elements of the cashpooling structure. 

b) Corporate power

For all Czech companies intending to participate in a cashpooling arrangement, the following corporate actions are recommended:

• Approval by the general meeting of shareholders should be obtained for each entity’s entry into the cash pooling arrangement. Provided that the approval is obtained for the general framework within which the individual loans will be made, only one general shareholders meeting will be needed to approve all of the undocumented loans.
• The articles of association of each Czech entity that will be a party to the arrangements should be reviewed to ensure compliance. This should consider any additional requirements concerning restrictions on indebtedness of the entity or on the types of agreements the entity is permitted to enter into, as well as any special conditions which may need to be fulfilled prior to entry into a cash pooling arrangement.
• Approval of other corporate bodies, such as board of directors or supervisory board is strongly recommended.

c) Cash pooling agreement

In order to reduce the risk of liability associated with a cashpooling arrangement, careful consideration must be given to the rights of the participating companies as regards provision of information and termination

(i) Right to information

The companies participating in a cashpooling arrangement should have the right to  receive regular up-to-date information relating to the financial position of the parent and the other participating companies if they are to ensure that funds they contribute to the cash pool will be repaid.

The participating companies should therefore agree that the parent has to provide the other participating companies with financial statements for the parent company and the group as a whole.

(ii) Right to terminate and to be repaid

The right of a company to terminate the cash pooling arrangement at any time in respect of itself and to be repaid any funds it has provided to the cash pool within undue delay is also important.

(iii) Arm’s length principle

The interest or other benefits received or paid by a Czech company under the cash pooling agreement should be set at a rate complying with the arm’s length principle, in particular to evidence that the directors  were acting on an informed basis and in a justifiable interest of the Czech company when entering in the cash pooling system.

It is, therefore, highly recommended that the cash pooling system gives the Czech company the opportunity to earn or pay interest at fair market rates. A regular review should also be carried out to ascertain whether the interest rate is at prevailing market value or whether it should be modified.

(iv) Avoiding certain payments from cash pooling

Specifically designated payments, such as subsidies or equity contributions should be excluded from cash pooling arrangements.

d) Facility agreement

It is usual that in addition to cash pooling agreement, a facility agreement is entered into between the bank and the participating companies, under which the participating companies are jointly and severally liable for any negative balance on the master account, and the participating companies are required to provide security and/or a guarantee for such negative balance. If possible, the participating companies should avoid such joint and several liability and security. If this is not possible, the company’s liability should be limited, e.g.  to the lesser of (i) the actual amount of funds drawn from the cash pool by the company at any one time and (ii) the amount by which its net assets exceed its liabilities. The liability of a company should also be fully excluded to the extent that such liability would lead to the insolvency of such company.

In addition cash pooling arrangements will often envisage that only the parent company may submit valid legal notices to the bank in respect of the cash pooling arrangement. It is important that this general rule does not prevent an individual participating company from terminating the individual cash pooling agreement to which it is party. Moreover, it is important that this termination right is synchronised with a corresponding right of the individual company in the facility agreement to terminate the facility agreement in relation to itself.

e) Guarantee

If possible, the participating companies should avoid the request of the bank to provide guarantee for any negative balance on the master account. If this is not possible, the company should seek a limitation of the guarantee to the lesser of (i) the actual amount of funds drawn from the cash pool by the company at any one time and (ii) the amount by which its net assets exceed its liabilities. In any case, the issued guarantee should be limited to avoid potential overindebtedness of the Czech company resulting into the statutory obligations to file for its insolvency. 

In the case of physical cash pooling, interest may be payable on sums lent and borrowed by the participating companies. Such interest payments will be subject to the usual tax rules regarding interest – in particular, taxation of interest earned on sums lent, deductibility of interest incurred on sums borrowed and thin capitalisation issues.

Under Czech income tax legislation, expenses incurred for the purpose of generating, ensuring or maintaining taxable income of a company are deductible. This includes interest expenses on loans under a cash pooling arrangement. However, if thin capitalisation rules are breached, any interest expenses claimed as a deduction are void and the tax liability is reinstated.

Generally, the parties are free to determine a rate of interest that will be charged on loans under the cash pooling arrangement. Regard should be given to thin capitalisation when deciding the rate of interest which should be charged. In addition, the requirement for the transaction to be at arm’s length will necessitate the provision of such loans at commercial rates of interest prevailing in the loans market for unaffiliated parties. If this is not ensured, the Czech Tax Authority may order that an adjustment be made to the taxable income of any entity under such an arrangement. These adjustments take the form of either a partial exclusion from the tax deductibility of a borrower entity’s interest expenses, or an increase in the tax base of any lender entity held to be charging interest at a rate considered too low.

In circumstances where it is difficult or impossible to assess objectively whether the particular terms of an arrangement comply with the arm’s length requirement, regard may be given to the OECD’s transfer pricing guidelines. The guidelines provide a useful frame-work for setting price valuations by explaining how to apply the arm’s length principle in considerable detail. Generally, the relevant taxpayer is required to show that the valuation method used delivered a reasonable “arm’s length” result.

It is also possible to obtain a binding assessment of the Czech tax authorities, confirming that the chosen rate of interest satisfies the arm’s length requirement. This, however, must be done prior to the entry into the cash pooling arrangement, as the authorities will not issue any retrospective assessment.

Restrictions in a state of emergency

Under Act No. 240/2000 Coll., the Crisis Act, as amended, if a state of emergency has been declared, the Czech Government may adopt certain measures such as the suspension of any payments from the Czech Republic abroad or from abroad to the Czech Republic for the period of such state of emergency.

We note that the above restriction is rather exceptional and has never been used and, when declared, maybe effective for up to 30 days maximum.